Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Sunday, 31 March 2013

Google
the phrase “money as debt”, and you’ll find numerous claims that the money
created by commercial banks is a form of debt, or that for every pound of such
money, there is a corresponding pound of debt.

This
idea is seems very plausible because whenever the commercial bank system
creates £X of new money the recipient of the new money seems to be “in debt” to
their bank to the tune of £X.

But
dig a little deeper, and the latter “in debt” idea falls to pieces.

We’ll start with a barter economy.

When
trying to solve a problem, it’s a good idea to take the simplest possible case
of the problem and solve that. Then add the complexities later.

So
let’s start with a simple barter economy where citizens decide that barter is
inefficient and that instead, they’ll allow commercial banks to set up and do
what such banks normally do: accept collateral from anyone wanting a stock of
money and crediting the accounts of those people with money produced from thin
air. So banks set up and embark on their “thin air” trick.

Now
at that stage, there isn’t just one debt, namely the obligation on the
“collateral supplier” to pay back the thin air money to the bank: there are two
others.

Debt
No. 2: there is an obligation on the bank to give back the collateral to the
collateral provider when the latter has paid back the thin air money. So that,
so to speak, cancels out debt No. 1.

Debt
No 3: thin air money actually consists of an entirely artificial debt owed by
the bank to the customer. And the basic promise made by the bank to the
customer is that the bank will transfer the debt to someone else when
instructed to do so by the customer: an instruction that can be conveyed to the
bank with a cheque, debt card or by other means.

Having
said that the latter debt is “artificial”, it is actually very real in the
sense of being legally binding. That is, when someone writes a cheque for £X
drawn on bank A and it’s deposited in bank B, bank B at the end of the working
day will want £X worth of central bank money from bank A. And if bank A cannot
come up the money, then bank A is on the path to bankruptcy.

To
summarise, there are two debts worth £X owed by the bank to the customer, and
one debt worth £X owed by the customer to the bank. And that nets out to £X
owed by the bank to the customer: quite the reverse of what we hear from the
“money is debt” brigade!!!!

So
at this stage, i.e. where banks have credited thin air money to customers
accounts, but before customers have spent any of the money, banks are in debt
to customers.

Interest.

The
interest paid or not paid on a debt is absolutely crucial, because if no
interest is paid, the debt really doesn’t matter. To illustrate, if the Bank of
England plonked a billion pounds worth of freshly printed £50 notes in my
garage, I’d then owe the BoE a billion. But that would be no problem for me as
long as I don’t have to pay interest!!

So
is any interest paid in respect of any of the above three debts? Well the quick
answer is “no”. But let’s run thru those debts just to verify that.

Re
debt No.1, the thin air money owed by the customer to the bank, the question as
to whether interest is charged here is a bit complex. You have been warned!

On
initially crediting a customers account with thin air money, the initial
charge/s made by banks varies widely from bank to bank. In particular some
banks structure their charges in very deceptive ways so as to draw in
customers, in much the same ways as supermarkets have so called “loss leaders”.

But
let’s assume that bank charges strictly reflects costs.

So
. . . on initially accepting collateral and crediting a customer’s account, a
bank will incur administration costs: e.g. the cost of checking up on the value
of the collateral, other staff costs, bank building maintenance costs, etc etc.
So the bank will charge customers for those costs.

Of
course some banks CALL THAT CHARGE “interest”. But it’s not interest at all!!!
(In contrast, other banks call the relevant charge an “overdraft arrangement
fee” or something like that).

What is interest?

In
view of the obvious need to distinguish between genuine interest and other
charges, let’s clarify exactly what “interest” is.

Interest
arises even in barter economies. That is, if in such an economy one person
lends a house or any other asset to a second person, the former will normally
want some sort of payment. The first person will have forgone the use of, and
enjoyment of the asset, and will want a reward for that sacrifice.

The
payment made by the second person may well include something for items OTHER
THANinterest. For example the above
house owner may pay the insurance or any number of other costs involved in
maintaining a house, and the owner will want those costs reimbursed by the
tenant. But that doesn’t detract from the basic point here, namely that asset
owners normally want a reward simply for forgoing the use or enjoyment of the
asset. And that is what’s called “interest”.

Now
in crediting the accounts of customers, does a bank transfer any sort of real
asset to the customer? The answer is “no”: all the bank has done is to write
numbers in a ledger – or as is the case since the advent of computers, type
numbers into a computer. So at that stage, there is no reason to charge
interest. Administration costs – yes. But interest- no.

Debt No.2.

This
is the obligation on the bank to give collateral back to the customer, and a
typical house owner certainly does not charge their bank interest here. (Things
are a little different in the World’s financial centres where interest or some
other charge is often made for lending out collateral, butwe’ll ignore that.)

Debt No.3.

This
is the fact that thin air money is an artificial debt owed by banks to
customers. Again, it is unheard of for customers to charge their banks interest
on that so called “debt”.

To
summarise, none of the above three debts are of any significance because no
interest is paid in respect of them.

The customer spends their thin air money.

The
next step is that a customer spends some of their thin air money. And “spending”
means giving money to someone in exchange forREAL ASSETS or REAL goods and services. Now let’s stop the clock again.

The
recipient of the money has forgone the use of real assets or goods. And as
explained above, people who make that sacrifice normally want interest.

In
fact in the real world, it is normal practice when one firm supplies goods to
another the expect payment within a month, and to charge interest if payment is
not forthcoming after a month or two.

Reverting
to our hypothetical economy, if someone who supplies goods and gets paid has no
intention of doing anything more (e.g. spending the money they got) they’d just
lodge the money in a bank deposit account and would try to get interest on it. And
you cannot blame them: they’ve lost REAL ASSETS OR GOODS, and got nothing REAL
in return. So they’ll want interest.

To
summarise, once our original bank customer makes some sort of PERMANENT
withdrawal of their thin air money by spending it, that means someone else has
sacrificed real goods or assets and will want interest as a reward.

In
short, people who deposit money in banks for a significant period normally try
to get interest on that money, which in turn means banks have to pass on that
interest to . . . well, to the people who have so speak helped themselves to
goods or assets belonging to others.

In
other words, when a bank charges genuine interest (as opposed to administration
charges or admin charges which are CALLED “interest”), the bank is simply
acting as a go-between and between two people, one of whom has supplied goods
or assets to another (just as they might have done in a barter economy). And as
is the case in a barter economy, the person conferring said assets or goods
will try to get interest.

To
summarise, where a bank charges genuine interest, thatis not a charge for creating money: it simply
reflects the fact that one person has supplied assets or goods to another, and
quite understandably wants interest. And the bank is simply acting as
go-between.

Is
money in a deposit account really money?

The
above arguments are supported by a procedure adopted by those charged with
measuring the money supply of countries round the world. That is, while money
in current or checking accounts is almost invariably counted as money, money in
deposit accounts tends not to be so counted. And the longer the “term” of the
deposit account, the less likely the so called money in that account is to be
actually counted as money. Plus, the longer the “term” of a deposit account,
the more interest it tends to pay.

Put
another way, as regards so called money which is quite clearly money (i.e.
money in current accounts) interest just doesn’t enter the picture – little or
no interest is earned normally on current accounts. So if anyone wants to claim
there is a debt here, or that for every pound of money there is a pound of
debt, then IN A SENSE they are right. But the real flaw in the latter claim is
that no interest is paid in respect of the debt.

So
just as where I’m in debt to the tune of a trillion trillion, the debt is
immaterial because no interest is paid.

Established banking systems.

To
recap, we’ve considered the scenario where there is initially no money, and
commercial banks create money and that money is spent. Another and more
realistic scenario is where a commercial bank system has been going for decades
or centuries, and that system effects a money supply increase (as it was doing
like there’s no tomorrow just prior to the recent crisis).

In
fact, much the same reasoning applies. To illustrate, a bank will charge for
ADMINISTRATION costs, but will not charge genuine interest for initially
creating money. Interest payments only arise where one entity has lodged money
in a bank for a significant period with a view to getting interest, which means
the bank has to pass that interest on to entities that have WITHDRAWN money for
significant periods from the bank.

But banning “debt money” WOULD reduce debts.

Having
argued that commercial banks “debt money” does not increase debts, there is
actually one transmission mechanism via which a ban on commercial bank money
creation WOULD reduce debts. It’s as follows.

The
above ban would obviously constrain lending by commercial banks, and the effect
would be deflationary. But that could easily be countered by having the
government / central bank machine create and spend new money into the economy.
The net result would be that all participants in the economy would have more
money and would thus not need to incur so much debt.

Friday, 29 March 2013

Dijsselbloem has claimed in respect of Cyprus that a “levy on
wealth is defendable in principle”. And Zero Hedge has chipped in with some
inconclusive verbiage which lends mild support to Dijsselbloem (if I’ve
interpreted the verbiage correctly).

Well banking apart, we’re all agreed that a “levy on wealth
is defendable in principle”. Likewise about 95% of the population approve in
principle of other taxes on the rich.

However, grabbing a portion of depositors’ money in a bank is
NOT A LEVY ON WEALTH!!!!!

It’s a levy on a PARTICULAR ASSET. That is , if it’s supposed
to be a levy on wealth, it’s the daftest levy on wealth ever thought of.

To illustrate, on the date of the levy some not desperately
wealthy people will have large amounts deposited in their bank for a variety of
possible reasons. For example they may have sold their house and haven’t yet
bought another. Or they may have just received a lump sum payment from their
pension provider. In contrast, there are
plenty of millionaires who far from having large amounts deposited in banks,
are heavily in debt to their bank.

It’s amazing that I even need to spell out the latter point.

It’s should be blindingly obvious that the Cyprus levy was a
panic and badly thought out move. But it DOES HAVE a limited amount of sense in
that it is a move towards full reserve banking: that’s a system under which,
first, it’s almost impossible for commercial banks to fail, and second, bank
subsidies are removed, and third, the tendency of banks to lend money into
existence during a boom (exactly when a money supply is not needed) is
constrained.

Now a system that has the latter three merits definitely has
something going for it. Thus a movement in the direction of full reserve, even
if it’s done in a chaotic Cyrus fashion, has some merit.

For more details on why a levy on depositors is part and
parcel of full reserve, see this Positive Money article.

Banks have shareholders, bondholders and
depositors. Shareholders allegedly perform a function: they foot the bill when
things go seriously wrong. In contrast, depositors and bondholders supply funds
on which they expect interest – a reward for forgoing consumption. But they
don’t expect to be first in line for a hair cut when things go badly wrong:
indeed, depositors don’t expect to take a hair cut at all (though of course
recent events in Cyprus have dented faith in the latter idea).

And that “division of labour” as between
shareholders and depositors seems to make sense: it seems to give people FLEXIBILITY
as regards what risks they want to accept and what costs they want to bear.

But there is a catch in the latter argument, and as
follows. There is already a HUGE VARIETY of different forms of saving and
investment available. For example in Britain people can put their money into
the ultra safe and government run “National Savings and Investments”. While at
the other end of the scale, savers can buy shares in a dodgy gold mine in a
developing country.

So why would anyone want to put their money into
anything other than an ultra safe form of saving, while at the same time
demanding 100% safety? Well it can only be because interest rates paid by the
more risky savings institutions are better – and precisely because of the additional
risk. In short, depositors who put their money into anything other than the
ultra-safe are demanding the right to the rewards of taking a risk at the same
time as being insulated against the downside of that risk.

IT’S NONSENSE !!!!

Put another way, wherever there is a risk over and
above the risk involved in an ultra-safe forms of saving, ALL ADDITIONAL
INTEREST should go to shareholders because they are the ones carrying the
additional risk.

So savers are being illogical when they lodge their
money in anything other than a 100% safe manner. But that raises the question
as to why savers ACTUALLY DO put their savings into commercial banks – i.e.
less than 100% safe types of saving.

Well the explanation is that they’ve found a “mug
insurer” who is prepared to cover the risks those depositors are taking, and at
an artificially low premium. The insurer is the taxpayer.

In short, the whole “shareholder / depositor”
symbiotic relationship is nothing more than an organised raid on the public
purse.

The raid has arisen because of various political
and populist forces: the corrupt banker / politician nexus, for example. Plus
there are well orchestrated mobs of depositors crying wolf when ever their
savings are threatened – or crying: “we want to have our cake and eat it”. Or
crying “We’re little old ladies relying on our pitifully small deposits to keep
body and soul together.”

Conclusion.

If there is little sense in having different types
of bank creditor (shareholders, depositors, etc), then that supports the case
for full reserve banking: the latter being a system in which depositors who
want their money loaned on by their bank have to foot the bill if those loans
go badly wrong. Put another way, full reserve is a system under which those
depositors are in effect shareholders.

And that ties up with the recent statement by
Mervyn King that British building societies are entities in which depositors
“are in effect the shareholders”.

Thursday, 28 March 2013

Here is an emperor with no clothes.
He’s stark bollocking naked. But as is always the case with naked emperors, no
one believes emperors, presidents etc could possibly parade in public with no
clothes on. So everyone sees clothes
where there are no clothes. Anyway the naked emperor is as follows.

Thousands of person hours and
tons of ink and paper have been devoted by Basel III / Dodd –Frank / Vickers
etc to the question as to what capital ratios banks should have. Allegedly a
higher ratio imposes additional costs on banks and Basel III has settled for a
3% ratio.

But wait a moment . . . as Mervyn
King rightly pointed out, the depositors at British building societies (roughly
equivalent to US savings and loan) “are in effect the shareholders”.

So in effect, the capital ratio
with building societies is 100%. Yet they compete very effectively with
banks!!!!!

So the whole “capital ratio” so
called dilemma is nonsense. And the reason it is nonsense was of course pointed
out by Messers Modigliani and Miller. That is, the risk of a particular bank
going bust is a given, thus the reward demanded by those accepting that risk is
a given. Thus the total number of shareholders amongst whom that risk is
divided has no effect on the total amount of risk. That is, if you up the
capital ratio, the risk per shareholder or per dollar of shares is reduced.

And if you go the extreme of
making ALL THE CREDITORS of a bank shareholders, as is the case with building
societies, that in no way hinders the ability of the relevant bank or similar
entity to compete.

Actually the latter couple of
paragraphs understate the point. That is, given a very small capital ratio, the
risk of a bank failing is INCREASED. For example if the ratio is 3%, then the
value of loans or investments made by the bank only needs to decline by about
3% and the bank is technically insolvent.

In contrast, if a bank’s only
creditors are shareholders (as per British building societies), it’s virtually
impossible for the building society / bank to become insolvent.

For another attack on the whole
bank capital ratio shambles, see this article in the Financial Times entitled “Why
bankers are intellectually naked” by Martin Wolf.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

.

Bits and bobs.

.

As I’ve explained for some time on this blog, the recently popular idea that “banks don’t intermediate: they create money” is over-simple. Reason is that they do a bit of both. So it’s nice to see an article that seems to agree with me. (h/t Stephanie Schulte). Mind - I've only skimmed thru the intro to that article.________

Half of landlords in one part of London do not declare rental income to the tax authorities. I might as well join in the fun. I’ll return my tax return to the authorities with a brief letter saying, “Dear Sirs, Thank you for your invitation to take part in your income tax scheme. Unfortunately I am very busy and do not have time. Yours, etc.”________

Simon Wren-Lewis (Oxford economics prof) describes having George Osborne in charge of the economy as being “similar to someone who has never learnt to drive, taking a car onto the highway and causing mayhem”. I’ll drink to that.

Unfortunately SW-L keeps very quiet, as he always does, about the contribution his own profession made to this mess. In particular he doesn’t mention Kenneth Rogoff, Carmen Reinhart or Alberto Alesina – all of them influential economists who over the last ten years have advocated limiting stimulus (because of “the debt”) if not full blown austerity.________

Plenty of support in the comments at this MMT site for the basic ideas behind full reserve banking, though the phrase “full reserve” is not actually used.________

Old Guardian article by Will Hutton claiming the UK should have joined the Euro. Classic Guardian and absolutely hilarious.________

One of the first “daler” coins (hence the word “dollar”) weighed 14kg.!!! Imagine going shopping for the groceries with some of those in your pocket, or should I say “in your wheelbarrow”. (h/t J.P.Koning)________

Moronic Fed official reveals that GDP tends to rise when population rises. Next up: Fed reveals that grass is green and water is wet….:-)________

Fran Boait of Positive Money says the Bank of England "has no capacity to respond to a future crisis, and that puts us in an extremely dangerous position." Well certainly there are plenty of twits at the Treasury and at the BoE who THINK responding will be difficult. Actually there's an easy solution: fiscal stimulus, funded (as suggested by Keynes) by new money. Indeed, that’s what PM itself advocates. But it’s far from clear how many people in high places have heard of Keynes or, where they have heard of him, know what his solution for unemployment was.________

The US debt ceiling has been suspended or lifted 84 times since it was first established. You’d think that having made the Earth shattering discovery 84 times that the debt ceiling is nonsense, that debt ceiling enthusiasts would have learned their lesson, wouldn’t you? I mean if I got drunk 24 times and had 24 car crashes soon afterwards, I’d probably get the point that alcohol causes car crashes…:-) As for getting drunk 84 times and having 84 car crashes, that would indicate extreme stupidity on my part. No?________

The US Treasury has the power to print money (rather in the same way as the UK Treasury printed money in the form of so called “Bradburies” at the outbreak of the first World War).________

“Payment Protection Insurance” was a trick used by UK banks: it involved surreptitiously getting customers to take out insurance against the possibility of not being able to make credit card or mortgage payments. UK banks have been forced to repay customers billions. But that’s just one example of a more general trick used by banks sometimes called “tying”: forcing, tricking or persuading customers to buy one bank product when they buy another. More details here on the Fed’s half-baked attempts to control tying in the US.________

The farcical story of economists’ apparent inability to raise inflation continues. As I’ve long pointed out, Robert Mugabe knows how to do that. In fact Mugabe should be in charge of economics at Harvard: he’d be a big improvement on Kenneth Rogoff, Carmen Reinhart and other ignoramuses at Harvard.________

I’ve removed comment moderation from this blog. The only reason I ever implemented it was so as get rid of commercial organisations advertising something and posing as commenters. When doing that I noticed comments were limited to people with Google accounts for some strange reason. Removed that as well. ________

Article on money creation by Prof Charles Adams, who as far as I can see is a professor of physics at my local university – Durham. I can’t fault the first half of his article, but don’t agree with the second half which claims both publically and privately issued money are needed because we have a public and private sector. I left a comment.

Adams is nowhere near the first physicist to take an interest in money creation. Another is William Hummel. These “physicist / economists” are normally very clued up (as befits someone with enough brain to be a physicist).________

.

MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A